A worrying lack of risk management

The scandal of Ireland’s Allied Irish Bank, coming in quick succession after that of Enron, has given rise to serious concerns that are perhaps being aired for the first time and in the context of a broader debate. This debate mainly centers on the credibility of independent auditors, internal auditing mechanisms of firms, and supposedly authoritative economic analysts that influence the share prices of giant enterprises. Such issues, which have moved to the forefront of debate in the international press, are still regarded in Greece as rather formidable and yet curious phenomena. Even so, they are insufficient wake-up calls to managers, auditing mechanisms and overseeing authorities involved in the complex modern financial system. In Greece, the recent scandal in ETBA Finance, the subsidiary of ETBA Bank, is a blatant example of the inadequacy of auditing mechanisms, which caused the loss of more than 30 million euros. It is generally recognized that Greek banks lack a modern risk management system, even though such a system would remain ineffective without experienced managerial staff. The relationship between the two is internationally recognized as so close that it is now proposed that a bank’s risk management system is linked to its credit rating as well as its capital sufficiency, as a high rating would indicate higher returns on capital and greater gains for shareholders. Further consideration is being given to the possibility of linking bonuses for management, not only with the profits of banks but also with the risk assumed to achieve them. Kathimerini posed the question to senior staff of auditing firms: «To what extent do the audits conducted meet actual requirements, and can the reports of such audits be considered adequate for the shareholders of a Greek bank?» «The situation is not ideal,» says one analyst who asked not to be named. «Basically, you cannot speak of full audits, as these are usually conducted on a sample basis. This is always of concern to us. Particularly after the scandals of Enron and of Allied Irish Bank, but also of Barings some years back, it is necessary to change the nucleus of the model used. Audits and procedures have to become more independent, internal bank audits to be strengthened, and we have to adopt management systems providing for a clear separation of the responsibilities and tasks of executives.» He adds that it is also necessary to introduce internal auditing bodies which should be presided over by independent, non-executive members of the bank’s board of directors, with strong personalities, deep knowledge of economic realities and who remain insulated from the influence of executive directors. «Auditors,» he continues, «must refer to this special body and have no other contact with management other than that required for obtaining the data required for the audit.» He insists that the role of management is predominant. Systems are insufficient, he says, without the people who can interpret data correctly, who will draw the appropriate conclusions and formulate the right strategy. Nevertheless, he recognizes that the Greek banking sector has certain important peculiarities which make monitoring difficult. «It is a market with a large growth potential, which means increases in the number of clients, loan portfolios, products and assets. The risk management system must be capable of evolving in order to monitor and cover the new requirements arising in a growing market. When you have high growth rates, you must audit and evaluate the risks arising from it.» Another senior analyst of a multinational auditing firm holds the view that balance sheets are not true. «This is not because firms deliberately seek this, but because they have specific methods of measuring and comparing data,» he says, adding that «there are serious distortions in the market.» A rather extreme but frequent occurrence is the lack of provisions for the clear separation of profit sources. «For instance, a firm’s management earned bonuses when it showed strong profit growth, but no one bothered to examine whether this was the result of capital gains from stock market operations as opposed to productive activities.» But ultimately, how are the interests of shareholders and the viability and healthy operation of a firm safeguarded? For one thing, auditors say, data is not the basic and main object of an audit. First of all, they look for really unusual indications, for instance excessively high profits in relation to other enterprises in their peer group; this may be a sign of concern. They also look into measures which management may have adopted for dealing with problems, decisions on crucial points, and the basic financial data on the basis of which a firm’s balance sheet may be held to depict a healthy financial situation. It is worth noting, nevertheless, that the two analysts seem to agree that the majority of Greek balance sheets provide a distorted picture of the real situation by not allowing comparisons with similar foreign enterprises. Finally, they draw attention to the responsibilities of analysts, who continue to be exempt from criticism and who frequently mislead the investing public into making risky choices. The latest such blatant example, says one of them, was the analysis of a large investment bank, on the eve of the Enron scandal, which painted a glowing picture of the corporation. «This excessive optimism alone,» he notes, «was a source of serious concern.»

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